Sequential lending with dynamic joint liability in micro-finance

This paper develops a theory of sequential lending in groups in micro-finance that centers on the notion of dynamic incentives, in particular the simple idea that default incentives should be relatively uniformly distributed across time. In a framework that allows project returns to accrue over time (rather than at a single point), as well as strategic default, we show that sequential lending can help resolve problems arising out of coordinated default, thus improving project efficiency vis-a-vis individual lending. Inter alia, we also provide a justification for the use of frequent repayment schemes, as well as demonstrate that, depending on how it is manifested, social capital has implications for project efficiency and borrower default. We then examine the optimal choices for the MFI, demonstrating that the MFI opts for higher project sizes under group lending with limited collusion, and also provide a plausible explanation of the transition from group to individual lending.